With a median price-to-earnings (or "P/E") ratio of close to 9x in Hong Kong, you could be forgiven for feeling indifferent about China Foods Limited's (HKG:506) P/E ratio of 9.9x. While this might not raise any eyebrows, if the P/E ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.
China Foods certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. It might be that many expect the strong earnings performance to deteriorate like the rest, which has kept the P/E from rising. If not, then existing shareholders have reason to be feeling optimistic about the future direction of the share price.
Check out our latest analysis for China Foods
What Are Growth Metrics Telling Us About The P/E?
There's an inherent assumption that a company should be matching the market for P/E ratios like China Foods' to be considered reasonable.
Taking a look back first, we see that the company grew earnings per share by an impressive 20% last year. The strong recent performance means it was also able to grow EPS by 70% in total over the last three years. So we can start by confirming that the company has done a great job of growing earnings over that time.
Looking ahead now, EPS is anticipated to climb by 4.2% each year during the coming three years according to the four analysts following the company. With the market predicted to deliver 16% growth per year, the company is positioned for a weaker earnings result.
With this information, we find it interesting that China Foods is trading at a fairly similar P/E to the market. It seems most investors are ignoring the fairly limited growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.
The Bottom Line On China Foods' P/E
It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.
Our examination of China Foods' analyst forecasts revealed that its inferior earnings outlook isn't impacting its P/E as much as we would have predicted. Right now we are uncomfortable with the P/E as the predicted future earnings aren't likely to support a more positive sentiment for long. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.
There are also other vital risk factors to consider before investing and we've discovered 1 warning sign for China Foods that you should be aware of.
If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.